1. Field of the Invention
This invention relates to a bi-currency debt contract system including guidelines and an attendant procedure for facilitating the security of debt made in a stabilized currency at an economically attractive interest rate to borrowing entities intending to use the proceeds of the debt in a secondary or historically unstable economy, wherein the debt is satisfied by payment in the stabilized currency and is to a large extent protected from unstable circumstances analogous to a devaluating exchange rate occurring within the secondary economy, by establishing a reserve fund and following other requirements of the bi-currency debt contract system and associated procedure.
2. Description of the Related Art
Even with the continued expansion of a global economy, a significant disparity between the economic stability of developed countries and underdeveloped countries continues to exist. This disparity is commonly demonstrated by the considerable difference in the cost of debt, which is at least partially attributable to the political risk, inflation, fiscal, and monetary policies, devaluation potential and the instability of the local currency in the secondary economies associated with the various underdeveloped countries.
By way of example only, companies in Latin American countries pay a substantially higher borrowing cost than their competitors in the United States and other developed countries. Local banks in such secondary economies must pay a substantially higher interest rate to depositors in their countries in order to keep the depositing clients from changing their assets from the local currency to US dollars or other hard currencies. Therefore, borrowers at the local banking institutions have to pay their loans at a much higher interest rate than in the United States or other countries enjoying low political risks, stable economies, sound fiscal and monetary policies and reliable and a stable currency.
In addition to the above there is usually the fear of accelerating devaluation as occurred in the two Mexican crisis of 1985 and 1994, which were universally recognized as the result of inappropriate economic policies. This type of economic instability is frequently present in underdeveloped countries even when the local currency thereof is relatively stable. The result, as set forth above, is a constant and significant difference in the cost of capital in the secondary economies and the more stable economies of the developed countries.
Because of the differences in the cost of debt and therefore the cost of doing business, a number of companies or other borrowing entities associated with the economies of an underdeveloped country are often times willing to take the risk of indebtedness at a lower interest rate in a stable currency, such as but not limited to the US dollar. Further by way of example, the difference in borrowing costs may be between a 9.5% lending rate in US dollars versus a 22% lending rate in the local currency of a secondary economy, such as the Dominican Republic. The obvious attraction to the borrowing entity is the significant decrease in the cost of the borrow money. The willingness to assume risks by those borrowing US dollars, or other hard currencies, is usually more prevalent during periods of relative economic stability in the related secondary economy, when the local currency is stable versus the US dollar. More specifically, companies may be willing to take the risk of devaluation of the local currency, which typically is the result of an occurrence of an economically unstable event for period time.
However, when severe devaluation does take place, a company or other borrowing entity that has assumed loans in US dollars are suddenly faced with substantially higher debt payments, in terms of their local devalued currency, even when inflation increases local prices. This inflationary rise in prices most often does not offset the increased obligations of the borrowing entity that must be met in US dollars, which ultimately is paid for in local currency converted to US dollars using a new, devalued exchange rate. Therefore, the risks of occurring debt in a hard or stable currency at a lower interest rate are realized when an economy suffers a rapid devaluation of the local currency, inflation and/or a contraction of economic growth. The resulting economic damages to the borrowing entity are normally defaulting or renegotiating loans made in the stable currency or the bankruptcy of the business or venture associated with the borrowing entity. In addition to the above and perhaps most, importantly, because of the above described “devaluation risk of the exchange rate”, financial institutions in the United States and other developed countries do not want to finance, through loans, numerous commercial ventures in countries characterized by high interest rates for local currency loans. As a result lending institutions in developed countries which deal in stable currencies, such as the United States, have a tendency to ignore a significant portion of the short and long term debt market.
When issuing any form of debt operation, the interest rate charged should reflect the risk involved in the business. As a further example, if one borrows US dollars but invests in a project in Mexican pesos, the risk involved should reflect the risk of doing business in the Mexican economy rather than the lower cost of borrowing a stable currency from a fundamentally sound economy. This mistake is commonly made when a loan is secured in a stable currency because the interest rate charged are lower, the borrowing entity taking the devaluation risk, calculates that it can assume business or commercial projects with relatively low opportunity costs of capital. When borrowing entities of this type prepare a profitability analysis using interest rates of developed countries which deal in a stable currency, conventional financial tools including “net present value” and “internal rate of return” are used. However, when the cost of doing business or making a loan is determined in terms of the lower cost of borrowing a stable currency, the results do not reflect the true financial and economic risks involved in the event of the occurrence of an unstable event in the secondary economy.
Normally the high interest rate in a local currency reflect the risk of doing business in that country. Risks, issuing debt, inflation expectations, political and economic stability are common factors affecting real rates of interest in underdeveloped countries. Accordingly, when a company borrows in order to invest in a project or business, the debt currency is normally the same as the currency invested. That is if a company borrows in Mexican pesos the money is invested in a Mexican business. The cost of issuing any debt reflects the risk of business in the local currency of that country. If a company is importing goods from the United States to Mexico and borrows Mexican pesos in order to buy dollars to pay the foreign supplier at the peso interest rate of any type of debt, that company is taking the exchange rate risk into consideration with respect of the US dollar. However, if devaluation occurs it would most likely cause an increase in the Mexican prices. The devaluation will probably result in sufficiently higher prices to off-set the devaluation cost that the Mexican company is paying in the higher debt costs of the Mexican interest rate. The Mexican company must calculate its profitability calculations with the Mexican interest rate, there by more accurately reflecting its “net present value” and “internal rates of return”.
Based on the factors and risks involved in any type of debt in stable currencies from developed countries for use in secondary or unstable economies, there is a significant need for a unique bi-currency debt contract system which overcomes the well recognized problems and disadvantages of the type set forth above. Such an improved system should comprise a bi-currency debt contract and/or procedure for issuing debt in a stabile currency, in a manner which protects both the debt issuer and borrower particularly when the proceeds of the debt are to be used in an underdeveloped country and/or secondary, potentially unstable economy.